Gustav L. Schmidt

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Fee shifting bylaws moved to back burner
Photo by Sharon Drummond

In a case of first impression, the Delaware Supreme Court held that provisions contained in a nonstock corporation’s bylaws, requiring a plaintiff stockholder to reimburse the corporation’s legal expenses if the plaintiff loses on a claim it has brought against the corporation, are facially valid if adopted properly and for a proper purpose (i.e., not for the purpose of deterring meritorious litigation). The court reached its conclusion in its May 8, 2014 decision based on the following factors and analysis: 

  • the Delaware General Corporation Law (“DGCL”) and other Delaware statutes did not forbid the enactment of fee-shifting bylaws;
  • the fee-shifting bylaw related to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees because it related to the allocation of risk in connection with intra-corporation litigation (DGCL § 109(b)); 
  • a provision for fee-shifting was not required to be included in the charter and could therefore be adopted in the bylaws (DGCL § 102(a)); and 
  • because the Delaware Supreme Court has held that bylaws are treated as contracts among a corporation’s stockholders, it was permissible to modify the American attorney’s fees rule (i.e., that each party in litigation bears its own costs and expenses) by adopting a fee-shifting bylaw. 

Because of the statutory basis of the court’s decision, the holding was presumed to also apply to ordinary stock corporations. Thus, a fee-shifting bylaw would likely allow Delaware corporations to require the loser of an intra-corporate lawsuit to pay the corporation’s attorney expenses. 

In response to the Delaware Supreme Court’s ruling, the Delaware State Bar Association (with significant plaintiff’s attorney membership) was considering a proposed amendment to the DGCL would amend Section 102(b)(6) and add a new Section 331 to clarify that these costs cannot be borne by stockholders of stock corporations. The proposed legislation was expected to be presented to the Delaware General Assembly before the end of the current session and, if passed, would have become effective on August 1, 2014. 

However, in a recent development,
Continue Reading Fee-shifting bylaw proposal moved to the back burner pending further investigation

Golden leashes
Photo by Don Urban

The compensation disclosure rules contained in Regulation S-K are intended to provide meaningful disclosure regarding an issuer’s executive and director compensation practices such that the investing public is provided with full and fair disclosure of material information on which to base informed investment and voting decisions. However, as we pointed out in a blog from last year, not all compensation is covered by these rules, including compensation paid to directors by third parties (e.g., by a private fund or activist investors). These arrangements are commonly known as “golden leashes.”  The two examples I discussed previously related to proxy fights involving Hess Corporation and Agrium, Inc. In each case, hedge funds had proposed to pay bonuses to the director nominees if they were ultimately elected to the board of directors in their respective proxy contests. Additionally, in the Agrium, Inc. case, the director nominees would have received 2.6% of the hedge fund’s net profit based on the increase in the issuer’s stock price from a prior measurement date. The amounts at issue could have been significant considering this particular hedge fund’s investment in Agrium, Inc. exceeded $1 billion, but none of the nominees were ultimately elected to the Agrium, Inc. board.

Considering the large personal gains these director nominees could potentially realize under these types of arrangements, it could pose a problem from a corporate governance standpoint as it is a long-standing principal of corporate law that directors are not permitted to use their position of trust and confidence to further their private interests. Recognizing this potential problem, the Council of Institutional Investors (“CII”), a nonprofit association of pension funds, other employee benefit funds, endowments and foundations with combined assets that exceed $3 trillion, recently wrote the SEC asking for a review of existing proxy rules “for ways to ensure complete information is provided to investors about such arrangements.”

In its letter, the CII points out that existing disclosure rules do not “specifically require disclosure of compensatory arrangements between a board nominee and the group that nominated such nominee.” The CII believes that disclosure related to these types of third party director compensation arrangements are material to investors due to the potential
Continue Reading Institutional investor organization asks the SEC to require disclosure of “golden leashes”

Golden leashes
Photo by Don Urban

The compensation disclosure rules contained in Regulation S-K are intended to provide meaningful disclosure regarding an issuer’s executive and director compensation practices such that the investing public is provided with full and fair disclosure of material information on which to base informed investment and voting decisions. However, as we pointed out in a blog from last year, not all compensation is covered by these rules, including compensation paid to directors by third parties (e.g., by a private fund or activist investors). These arrangements are commonly known as “golden leashes.”  The two examples I discussed previously related to proxy fights involving Hess Corporation and Agrium, Inc. In each case, hedge funds had proposed to pay bonuses to the director nominees if they were ultimately elected to the board of directors in their respective proxy contests. Additionally, in the Agrium, Inc. case, the director nominees would have received 2.6% of the hedge fund’s net profit based on the increase in the issuer’s stock price from a prior measurement date. The amounts at issue could have been significant considering this particular hedge fund’s investment in Agrium, Inc. exceeded $1 billion, but none of the nominees were ultimately elected to the Agrium, Inc. board.

Considering the large personal gains these director nominees could potentially realize under these types of arrangements, it could pose a problem from a corporate governance standpoint as it is a long-standing principal of corporate law that directors are not permitted to use their position of trust and confidence to further their private interests. Recognizing this potential problem, the Council of Institutional Investors (“CII”), a nonprofit association of pension funds, other employee benefit funds, endowments and foundations with combined assets that exceed $3 trillion, recently wrote the SEC asking for a review of existing proxy rules “for ways to ensure complete information is provided to investors about such arrangements.”

In its letter, the CII points out that existing disclosure rules do not “specifically require disclosure of compensatory arrangements between a board nominee and the group that nominated such nominee.” The CII believes that disclosure related to these types of third party director compensation arrangements are material to investors due to the potential
Continue Reading Institutional investor organization asks the SEC to require disclosure of "golden leashes"

Section 108 of the Jump Start Our Business Startups Actrequired the

Study states more studies required - similar to a punt?
Photo by Duke University Archives

SEC to undertake a study of the disclosure requirements of Regulation S-K. Specifically, the statute mandated that the SEC shall:

conduct a review of its Regulation S-K to—

  1. comprehensively analyze the current registration requirements of such regulation; and
  2. determine how such requirements can be updated to modernize and simplify the registration process and reduce the costs and other burdens associated with these requirements for issuers who are emerging growth companies.

In addition, the JOBS Act required that the SEC report to Congress its specific recommendations on how to streamline the registration process in order to make it more efficient and less burdensome for prospective issuers who qualify as emerging growth companies.

That report was released not too long ago on December 20, 2013. However, it seems like the Commission elected to punt on the second part of the legislative mandate (i.e., to provide specifics), at least for now. Unfortunately, as is so often the case with governmental studies, the primary recommendation by the SEC Staff was to conduct further studies and investigations.  While disclosure reform is complex (and may be politically charged), further studies is not what investors or the capital markets need.  Too much money is spent on preparing duplicative and meaningless disclosures.

The report describes in great detail the history and evolution of the disclosure requirements contained in Regulation S-K – the primary source of disclosure requirements for registration statements and periodic reports filed by public companies with the SEC. All of this is well and good for government regulation historians and SEC buffs, but it provides nothing of real value to companies that are or may become subject to these rules and requirements. However, the report provides no real useful guidance to Congress (which may be the point if the SEC would rather control the reform process itself rather than have Congress control the process). Presumably, Congress had included this section in the JOBS Act for a specific purpose:
Continue Reading 4th and 108, SEC elects to punt on Regulation S-K disclosure reform

SEC gets an A+ for proposed Regulation A+ rulesOne of the most anticipated items from the JOBS Act enacted in April 2012 was the so-called Regulation  A+ –  a new and improved exemption that would allow issuers to raise up to $50 million in a 12-month period through a “mini-registration” process that is similar to that of rarely used Regulation A exemption. On December 18, 2013, the SEC issued its proposed rules which were mandated under Title IV of the JOBS Act.

The proposed rules would amend the current Regulation A to create two tiers of exempt offerings. Tier I would become the current Regulation A exemption, which maintains the $5 million offering limitation. Tier II would implement Regulation A+ and would permit offerings of up $50 million in any 12-month period.

Since its implementation years ago, Regulation A has not received widespread use, primarily because it did not provide for preemption of state securities laws and also had a relatively modest dollar limitation on the amount that could be raised. However, Regulation A+ (i.e., Tier II) promises to be a significant improvement over the old Regulation A because of the increased dollar limitation and the other benefits, including the potential preemption of state securities laws and regulations in certain circumstances.

All 387 pages of the proposed rules can be read on the SEC’s website, but a summary of these proposed rules are provided below for those not inclined read the entire release.

Issuer Eligibility

As proposed, Regulation A+ would be available only to United States and Canadian companies that have their principal place of business in the U.S. or Canada. Like the current Regulation A exemption, the Regulation A+ would not be available to certain types of issuers, such as companies that are already SEC reporting companies, registered investment companies and “blank-check companies.” However, under the currently proposed rules, shell companies may avail themselves of the Regulation A+ exemption so long as they are not blank-check companies.

Eligible Securities

The securities that may be offered under Regulation A are limited to equity securities, debt securities and debt  securities convertible into or exchangeable into equity interests, including any guarantees of such securities, but would exclude asset-backed securities.

Investor Limitations

As proposed, investors in a Tier II offering may acquire no more than
Continue Reading The SEC gets an A+ with the proposed “Regulation A+” rules

FDIC Statement of Policy on Bank Stock OfferingsWith the costs of compliance on the rise, we are seeing some significant consolidation in the banking industry, particularly among community banks. In a recent article on www.bankdirector.com, Rick Maroney writes that although bank M&A has been tepid thus far in 2013, some key drivers of M&A activity are starting to emerge and he predicts that we are likely to see increased merger and consolidation activity in the industry as smaller banks need to grow to remain viable. Additionally, the heightened regulatory capital requirements that are expected to be adopted as a result the Basel III accord may be an additional driver of consolidation in the banking sector.

In these merger transactions, it is fairly common for acquiring institutions to offer its common stock to target shareholders as part of the consideration to be paid. Depending on the organizational structure of the acquiring institution, there are a few options for offering stock to target shareholders as merger consideration. If the acquiror is a bank with a holding company structure, the stock portion of the merger consideration is almost always common stock of the holding company. The most significant issue when offering bank holding company stock is that the transaction must either (i) be registered on an S-4 registration statement, which involves substantial time and cost for the acquiror and would subject the acquiror to periodic reporting requirements under the Securities Exchange Act of 1934 or (ii) alternatively, the holding company stock must be issued pursuant to an exemption from registration (typically the Rule 506 safe-harbor for the Section 4(a)(2) private offering exemption). Many smaller banks, to the extent possible, will attempt to avoid registering the transaction due to the high costs and rely on an exemption to registration. If an acquiror considers privately placing holding company securities in a merger transaction, there are a number of considerations to address, some of which may be slightly alleviated by the recent changes under the JOBS Act as described in Kobi Kasitel’s recent blog post regarding stock issuances in M&A transactions after the JOBS Act.

For state-chartered banks regulated by the FDIC that do not have a holding company, the issuance of bank stock in connection with an acquisition may, at first glance, appear simpler. Under section 3(a)(2) of the Securities Act of 1933, securities issued or guaranteed by a bank are exempt securities and may be issued
Continue Reading The FDIC should consider updating its outdated statement of policy on bank stock offerings

CEO pay ratio disclosure will not have the intended effectCompensation of public company executives re-emerged back into the public limelight after the recent financial crisis which began in late 2007. The public perception was one of outrage in large part due to the fact that many investors in public companies were experiencing significant losses in their investment portfolios while CEOs and other executives were still being paid record levels of compensation and bonuses.

As a direct result, Congress enacted a number of new laws intended to fix these perceived social injustices, most of which were included in the Dodd-Frank Act. Section 953(b) of Dodd-Frank, for example, was a highly controversial part of Dodd-Frank which directed the SEC to adopt rules requiring  public companies to disclose the ratio of the CEO’s total compensation to that of its median employee. The crux of the controversy surrounding this rule related to how companies should determine median employee salary. Should part-time employees be included or just full-time employees? How should companies treat international employees in countries that have significantly lower relative wages as compared to the U.S.? Another concern of critics was whether the pay ratio metric was useful for investors.

On September 18, 2013, the SEC promulgated proposed rules regarding CEO pay ratio disclosures. As required by the Dodd-Frank Act, the proposal would amend existing executive compensation disclosure rules to require companies to disclose:

  • The median of the annual total compensation of all its employees except the CEO.
  • The annual total compensation of its CEO.
  • The ratio of the two amounts.

The proposed rule would not specify any required calculation methodologies for identifying the median employee in terms of total compensation for all employees.  Instead, it would allow companies to select a methodology that is appropriate to the size and structure of their own businesses and the way they compensate employees.

Like the other SEC disclosure rules mandated by Dodd-Frank, it seems that Congress is attempting to indirectly fix situations it views as problematic for one reason or another by mandating that public companies disclose certain things in their public filings. I presume the thought is that companies will be incentivized to change their practices so as not to be publicly shamed through these disclosures in their public filings. My presumption is supported, to some extent, by
Continue Reading Government mandated pay ratio disclosure will fail to achieve its intended objectives

SEC reminds you to have a disaster recovery planAlmost 10 months since Superstorm Sandy caused widespread destruction to the northeastern U.S., an area not known for frequent hurricane activity, the people and businesses affected have still not fully recovered. As we now reenter the peak of hurricane season, businesses along the eastern seaboard are probably taking a closer look now than in years past at their disaster preparedness in light of last year’s events. The impact of Hurricane Sandy was certainly not limited to the U.S. In reality, there were global implications as, for example, U.S. equity and options markets were closed for two full trading days following the storm. As a result, the SEC, FINRA and the CFTC undertook a joint review of their individual business continuity and disaster recovery planning. Last week, on August 16, these three regulatory agencies issued a joint release outlining some lessons learned and best practices noted in their investigations and review.

The release focused on a number of specific areas including:

  • Widespread disruption considerations;
  • Alternative locations considerations;
  • Vendor relationships;
  • Telecommunications services and technology considerations;
  • Communication plans;
  • Regulatory and compliance consideration; and
  • Review and testing.

The primary motif in the release was that
Continue Reading Hurricanes, flash freezes and other disasters – plan and disclose accordingly or you may be hearing from the SEC

Advertising rules may still limit selling securitiesAlthough the SEC recently finalized rules that will remove the ban on general solicitation and advertising for certain private offerings under Rule 506 of Regulation D, it does not mean that issuers will have free reign and complete discretion over their use of advertisements. That is, issuers looking to locate potential investors through advertising after the new rules become effective in September may still be subject to other laws that will restrict the manner in which they advertise or solicit investments.

For example as Keith Bishop over at the California Corporate & Securities Law Blog points out in a recent post that certain other state laws may be implicated with these types of advertisements. According to the post, in California, Rule 260.302 of the California Code of Regulations states, in part, that:

 An advertisement should not contain any statement or inference that an investment in the security is safe, or that continuation of earnings or dividends is assured, or that failure, loss, or default is impossible or unlikely.”

Thus, it is possible that states could use advertising laws and regulations to regulate, to some extent, private offerings under the new Rule 506. However, the question remains, as to how far these types of state laws and regulations can go? The answer to this question is
Continue Reading Removal of ban on general solicitation and advertising won’t be a license for issuers to say anything they want

With newer methods to communicate and interact with the so-called social network popping up on almost a daily basis, securities regulators have been giving more and more attention to social media and how companies and certain regulated professionals are employing it. As we discussed in a previous blog, the SEC has signed off on public companies utilizing social media for disclosure purposes, provided that, among other things, companies disclose to investors the types of social media outlets they will employ for such purposes. The SEC has issued guidance on the use of social media by public companies for Regulation FD and other disclosure purposes, which can be found in this SEC Press Release and in the SEC’s report on its investigation of the Facebook postings made by Netflix’s CEO.

Now it appears that social media is gaining the attention of FINRA as well, the primary self-regulatory organization for registered broker-dealers. As reported in a recent article on CNN, FINRA wants state privacy laws to provide exemptions for registered broker-dealer firms that would permit such firms to access Facebook and other social media accounts of their associated persons (i.e., stockbrokers). Because of the prominence and proliferation of Facebook and the personal or sensitive nature of the information contained on an individual’s Facebook page and other social media accounts, state legislatures have proactively enacted legislation that prevent or restrict companies from monitoring employees through social media. According to the National Conference on State Legislatures, six states enacted legislation in 2012 that prohibits employers from requesting or requiring an employee, student or applicant to disclose a user name or password for a personal social media account.

FINRA is concerned, however, that prohibiting access to employee social media accounts may affect a registered broker-dealer’s ability to fully comply with its mandated supervisory duties under federal laws and regulations. For example, registered broker-dealers are required to maintain copies of all “business communications” as discussed in guidance issued by FINRA in Regulatory Notice 11-39. Under Rule 17a-4(b)(4) of the Exchange Act, “business communication” includes “[o]riginals of all communications received and copies of all communications sent (and any approvals thereof) by the member, broker or dealer (including inter-office memoranda and communications) relating to its business as such, including all communications which are subject to rules of a self-regulatory organization of which the member, broker or dealer is a member regarding communications with the public.” Thus, if a stockbroker is using social media to
Continue Reading Social media and brokers: FINRA wants broker-dealers to be “friends” with their employees